What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-08-15 compared with 2022-05-16 · 190 added, 100 removed, 249 unchanged (54% of the section changed)

1 unchanged sentence

Unless the context clearly suggests otherwise, references to “the Company”, “we”, “our”, and “us” in the remainder of this report are to Shore Bancshares, Inc.

and its consolidated subsidiary.

and its consolidated subsidiaries.

Forward-Looking Information

17 unchanged sentences

The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank, N.A.

The Company also engages in title work for real estate transactions through Mid-MD Title.

The shares of common stock of Shore Bancshares, Inc.

25 unchanged sentences

Purchased performing loans are recorded at fair value, including a credit discount.

The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans.

The fair value discount is accreted as an adjustment to yield over the estimated lives of the

There is no allowance for loan losses established at the acquisition date for purchased performing loans.

11 unchanged sentences

If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss.

As of March 31, 2022, the Company had a banking and mortgage reporting unit.

The Company reported net income of $5.6 million for the first quarter of 2022, or diluted income per common share of $0.28, compared to net income of $4.0 million, or diluted income per common share of $0.34, for the first quarter of 2021.

For the fourth quarter of 2021, the Company reported net income of $2.7 million, or diluted income per common share of $0.16.

Net income, excluding merger related expenses, for the first quarter of 2022 was $6.2 million or $0.31 per diluted common share, compared to net income, excluding merger related expenses, of $7.9 million or $0.46 per diluted common share for the fourth quarter of 2021.

When comparing net income, excluding merger related expenses, for the first quarter of 2022 to the first quarter of 2021, net income increased $2.4 million, primarily due to increases in net interest income of $8.6 million and noninterest income of $3.5 million, partially offset by an increase in noninterest expenses of $9.1 million.

When comparing the first quarter of 2022 to the fourth quarter of 2021, net income, excluding merger related expenses, decreased $1.8 million, due to increases in noninterest expenses of $3.7 million and the cumulative impact of a reversal of the provision for credit losses of $1.7 million in the fourth quarter of 2021 and a provision of $600 thousand in the first quarter of 2022, partially offset by increases in net interest income of $1.8 million and noninterest income of $917 thousand.

Merger-related expenses were recorded for the first quarter of 2022 and the fourth quarter of 2021 of $730 thousand and $7.6 million, respectively.

As of June 30, 2022, the Company had a banking and mortgage reporting unit.

The Company reported net income of $7.5 million for the second quarter of 2022, or diluted income per common share of $0.38, compared to net income of $4.0 million, or diluted income per common share of $0.34, for the second quarter of 2021.

For the first quarter of 2022, the Company reported net income of $5.6 million, or diluted income per common share of $0.28.

Net income, excluding merger related expenses, for the second quarter of 2022 was $7.7 million or $0.39 per diluted common share, compared to net income, excluding merger related expenses, of $6.2 million or $0.31 per diluted common share for the first quarter of 2022.

When comparing net income, excluding merger related expenses, for the second quarter of 2022 to the second quarter of 2021, net income increased $3.3 million, primarily due to increases in net interest income of $10.5 million and noninterest income of $2.9 million, partially offset by an increase in noninterest expenses of $9.4 million resulting from the acquisition of Severn Bank (“Severn”) in November 2021.

When comparing the second quarter of 2022 to the first quarter of 2022, net income, excluding merger related expenses, increased $1.5 million, due to increases in net interest income of $2.2 million and a lower provision of credit losses of $400 thousand.

Merger-related expenses were recorded for the second quarter of 2022 and the first quarter of 2022 of $241 thousand and $730 thousand, respectively.

For the first six months of 2022, the Company reported net income of $13.1 million, or diluted income per common share of $0.66, compared to net income of $8.0 million, or diluted income per common share of $0.68, for the first six months of 2021.

When comparing net income for the first six months of 2022 to the first six months of 2021, the increase in net income was primarily due to an increase in net interest income of $19.1 million and noninterest income of $6.4 million.

These improvements to income were partially offset by an increase in noninterest expense of $19.1 million resulting from the Severn merger.

RESULTS OF OPERATIONS

1 unchanged sentence

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments.

As shown in the table below, tax-equivalent net interest income was $22.5 million for the first quarter of 2022 and $13.8 million for the first quarter of 2021.

Tax-equivalent net interest income was $20.7 million for the fourth quarter of 2021.

The increase in net interest income when comparing the first quarter of 2022 to the first quarter of 2021 and the fourth quarter of 2021, was due to increases in interest and fees on loans and income from taxable investment securities, partially offset by increases in interest expense on interest-bearing deposits and subordinated debt primarily due to the acquisition of Severn.

As shown in the table below, tax-equivalent net interest income was $24.7 million for the second quarter

of 2022 and $14.1 million for the second quarter of 2021.

Tax-equivalent net interest income was $22.5 million for the first quarter of 2022.

The increase in net interest income when comparing the second quarter of 2022 to the second quarter of 2021 and the first quarter of 2022, was due to increases in interest and fees on loans and income from taxable investment securities, partially offset by increases in interest expense on interest-bearing deposits and subordinated debt primarily due to the acquisition of Severn.

Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets.

The net interest margin for the first quarter of 2022 was 2.78%, which was a decrease of 22bps when compared to 3.00% for the first quarter of 2021 and a decrease of 9bps when compared to 2.87% for the fourth quarter of 2021.

The decline in net interest margin in the first quarter of 2022 when compared to the first quarter of 2021 was significantly impacted by excess liquidity and higher average balances on lower yielding assets, coupled with additional

borrowings resulting from the Severn acquisition.

The decline in net interest margin when compared to the fourth quarter of 2021, was primarily due to a decline in the yields of loans due to lower accretion income and organic loan growth experienced late in the first quarter of 2022.

Without estimated excess liquidity of $400 million, the margin for the first quarter of 2022 would have been 3.07%.

The net interest margin for the second quarter of 2022 was 3.10% which was an increase of 19bps when compared to 2.91% for the second quarter of 2021 and an increase of 32bps when compared to 2.78% for the first quarter of 2022.

The improvement in net interest margin in the second quarter of 2022 when compared to the second quarter of 2021 and the first quarter of 2022 was due to higher average loan balances, accretion income from purchased loans and higher rates paid on lower yielding assets.

Interest Income

On a tax-equivalent basis, interest income increased $9.0 million, or 58.4%, for the first quarter of 2022 when compared to the first quarter of 2021.

On a tax-equivalent basis, interest income increased $11.1 million, or 71.6%, for the second quarter of 2022 when compared to the second quarter of 2021.

The improvement to interest income was the result of increases in interest and fees on loans, income from investment securities and higher rates paid on interest-bearing deposits with other banks.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $684.9 million, coupled with a higher average yield of 17bps, partially impacted by PPP forgiveness and accretion income from the acquired loan portfolio of Severn in the first quarter of 2022.

The average balance of taxable investment securities increased $303.2 million, providing $1.1 million of additional income, despite a decrease in the average yield of 14bps.

On a tax-equivalent basis, interest income increased $1.9 million, or 8.6%, for the first quarter of 2022 when compared to the fourth quarter of 2021.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $772.5 million, significantly impacted by the acquisition of Severn in the fourth quarter of 2021 coupled with a higher average yield of 25bps.

The average balance of taxable investment securities increased $260.1 million, providing $1.3 million of additional income.

On a tax-equivalent basis, interest income increased $2.3 million, or 9.6%, for the second quarter of 2022 when compared to the first quarter of 2022.

The increase was primarily a result of growth in the average balance in loans of $81.4 million, or 3.8%.

In addition, the average balance of taxable investment securities increased $62.3 million and the average yield increased 7bps, which provided $322 thousand of additional income.

In addition, the average balance of taxable investment securities increased $15.2 million, or 2.9%, and the average yield increased 26bps, which provided $407 thousand of additional income.

Interest Expense

Interest expense increased $350 thousand, or 22.7%, when comparing the first quarter of 2022 to the first quarter of 2021.

The increase in interest expense from the first quarter of 2021 was the result of increases in expenses on interest-bearing deposits of $174 thousand and both long-term advances from FHLB and subordinated debt for a combined $175 thousand.

Interest expense increased $137 thousand, or 7.8%, when comparing the first quarter of 2022 to the fourth quarter of 2021 primarily due to an increase in interest expense on deposits.

The increase in interest expense on deposits was due to an increase in the average balance of interest-bearing deposits of $284.4 million, or 15.4%, the result of both a full quarter of deposits acquired from Severn and $93.3 million in organic deposit growth during the first quarter of 2022.

The rates paid on interest-bearing deposits decreased slightly to 26bps in the first quarter of 2022 from 27 bps in the fourth quarter of 2021, maintaining a low cost of funds on core deposits.

In addition, the increase in interest expense was impacted by a full quarter of additional long-term advances from the FHLB and, junior subordinated debt acquired from Severn.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended March 31, 2022 and 2021.

Interest expense increased $624 thousand, or 43.7%, when comparing the second quarter of 2022 to the second quarter of 2021.

The increase in interest expense from the second quarter of 2021 was the result of increases in expenses on interest-bearing deposits of $455 thousand and both long-term advances from FHLB and subordinated debt for a combined $171 thousand all of which were significantly impacted by the acquisition of Severn in the 4 th quarter of 2021.

Interest expense increased $158 thousand, or 8.3%, when comparing the second quarter of 2022 to the first quarter of 2022 primarily due to an increase in interest expense on deposits.

The rates paid on interest-bearing deposits increased slightly to 29bps in the second quarter of 2022 from 26 bps in the first quarter of 2022.

For Three Months Ended

March 31, 2022

March 31, 2021

June 30, 2022

June 30, 2021

(Dollars in thousands)

13 unchanged sentences

Securities sold under retail repurchase agreements and short-term FHLB advances

Advances from FHLB - short-term

Advances from FHLB - long-term

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Tax-equivalent adjustment

(1) All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%,

exclusive of nondeductible interest expense.

(2) Average loan balances include nonaccrual loans.

(3) Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Net Interest Income

Tax-equivalent net interest income increased $19.1 million, or 68.4%, during the six months ended June 30, 2022 compared to the six months ended June 30, 2021.

The higher net interest income was due to an increase in interest income of $20.1 million, or 65.0%, specifically increased interest and fees on loans of $16.8 million, or 58.3%, primarily due to an increase in the average loan balance of $740.5 million, or 51.1%, coupled with accretion income from acquired loans of $1.5 million for the six months of 2022.

Taxable investment securities and interest on deposits with other banks increased $2.4 million and $978 thousand, respectively.

The increase in interest expense was the result of an increase in the average balance on interest bearing deposits of $860.6 million, or 68.1%, despite the rates paid on the deposits declining 9bps.

Interest on long term borrowings increased by $346 thousand due to the acquisition of long-term advances from the FHLB and junior subordinated debt acquired as part of the Severn acquisition.

This resulted in a net interest margin of 2.94% for the six months ended June 30, 2022 compared to 2.96% for the six months ended June 30, 2021.

Interest Income

On a tax-equivalent basis, interest income increased $20.1 million, or 65.0%, for the six months ended June 30, 2022 when compared to the six months ended June 30, 2021.

The increase was primarily due to higher interest and fees on loans of $16.8 million, or 58.3%, and taxable investment securities of $2.4 million, or 116.1%.

The increase in interest and fees on loans was due to a higher average balance of loans of $740.5 million, or 51.1%, primarily due to the acquisition of Severn in the 4 th quarter of 2021.

The increase in interest on taxable investment securities was due to a higher average balance in these securities of $281.5 million, or 109.5%.

Interest Expense

Interest expense increased $974 thousand, or 32.8%, when comparing the six months ended June 30, 2022 to the six months ended June 30, 2021.

The increase in interest expense was the result of an increase in interest-bearing deposits of $860.6 million, or 68.1%, despite the rates paid on these accounts declining 9bps.

Interest on long-term borrowings increased by $346 thousand due to the acquisition of long-term advances with the FHLB and junior subordinated debt acquired as part of the Severn acquisition.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the six months ended June 30, 2022 and 2021.

For Six Months Ended

June 30, 2022

June 30, 2021

(Dollars in thousands)

Earning assets

Loans (2), (3)

Investment securities:

Interest-bearing deposits

Total earning assets

Cash and due from banks

Allowance for credit losses

Interest-bearing liabilities

Demand deposits

Money market and savings deposits

Certificates of deposit $100,000 or more

Other time deposits

Interest-bearing deposits

Securities sold under retail repurchase agreements and federal funds purchased

Advances from FHLB - long-term

Subordinated debt

Total interest-bearing liabilities

Noninterest-bearing deposits

Other liabilities

Stockholders’ equity

Total liabilities and stockholders’ equity

Net interest spread

Net interest margin

Tax-equivalent adjustment

(1) All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.

2 unchanged sentences

Noninterest Income

Total noninterest income for the first quarter of 2022 increased $3.5 million, or 136.4%, when compared to the first quarter of 2021.

The increase from the first quarter of 2021 was across all noninterest income categories but was primarily due to the expenses related to the addition of the mortgage division of $1.9 million, service charges on deposit accounts of $685 thousand, additional rental fee income of $345 thousand and Mid-Maryland Title Company revenue of $323 thousand.

Noninterest income increased $917 thousand, or 17.9%, when compared to the fourth quarter of 2021 primarily due to higher revenue from the mortgage division of $919 thousand, increase in service charges on deposits of $125 thousand, and higher revenue from the Mid-Maryland Title Company of $75 thousand, partially offset by a reduction in other noninterest income primarily related to higher expenses related to retirement funding costs as well as lower other loan fee income.

Total noninterest income for the second quarter of 2022 increased $2.9 million, or 100.9%, when compared to the second quarter of 2021.

The increase from the second quarter of 2021 was across all noninterest income categories but was largely the result of the addition of Severn in the fourth quarter of 2021 which drove mortgage banking revenue of $1.1 million and Mid-Maryland Title Company revenue of $426 thousand, service charges on deposit accounts of $755 thousand and interchange fees of $217 thousand.

Noninterest income decreased $213 thousand, or 3.5%, when compared to the first quarter of 2022 primarily due to a decrease in revenue from the mortgage division of $771 thousand, partially offset by increases in interchange fees of $215 thousand, and higher revenue from the Mid-Maryland Title Company of $103 thousand.

Total noninterest income for the six months ended June 30, 2022 increased $6.4 million, or 117.6%, when compared to the same period in 2021.

The increase in noninterest income primarily consisted of revenue associated with the mortgage division, service charges on deposit related fees, title company revenue and other noninterest income.

The increases in

other noninterest income were primarily due to increases in rental income and other loan fee income as a result of the Severn acquisition.

Noninterest Expense

Total noninterest expense, excluding merger-related expenses, for the first quarter of 2022 increased $9.1 million, or 86.7%, when compared to the first quarter of 2021 and increased $3.7 million, or 15.8%, when compared to the fourth quarter of 2021.

The increase in noninterest expense when compared to both the first quarter of 2021 and fourth quarter of 2021 was primarily due to increases in salaries and wages, employee related benefits, occupancy expense, data processing, amortization of intangible assets and legal and professional fees, which were all significantly impacted by adding Severn branches and its operations for a full quarter in 2022.In addition, salaries and wages were impacted by incentive increases which took effect in January of 2022.

Total noninterest expense for the second quarter of 2022, excluding merger-related expenses, increased $9.4 million, or 89.1%, when compared to the second quarter of 2021 and increased $251 thousand, or 1.2%, when compared to the first quarter of 2022.

The increase in noninterest expense when compared to the second quarter of 2021 was primarily due to increases in salaries and wages, employee related benefits, occupancy expense, data processing, amortization of intangible assets and legal and professional fees, which were all significantly impacted by adding Severn branches and its operations.

The increase in noninterest expense when compared to the first quarter of 2022 was primarily due to increases in fee and loan servicing expenses as well as derivatives expense.

Total noninterest expense for the six months ended June 30, 2022, excluding merger-related expenses, increased $18.5 million, or 87.9%, when compared to the same period in 2021.

The increase was primarily a result of higher salaries, employee benefits, occupancy expense, other intangibles, data processing costs, other noninterest expenses, and FDIC insurance premiums due to significant increases in new and existing customers and the acquisition of Severn.

Provision for Credit Losses

The provision for credit losses was $600 thousand for the first quarter of 2022, $425 thousand for the first quarter of 2021 and $(1.7) million for the fourth quarter of 2021.

The ratio of the allowance for credit losses to period-end loans was 0.67% at March 31, 2022, 0.66% at December 31, 2021 and 0.98% at March 30, 2021.

Excluding PPP loans and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.92% at March 31, 2022, slightly lower than the 0.93% at December 31, 2021 and lower than the 1.11% at March 31, 2021.

The primary driver of the decreased percentage of the allowance to total loans, excluding PPP loans, as compared to December 31, 2021, was due to further reduced pandemic qualitative factors.

The decrease in the percentage of the allowance to total loans, excluding PPP loans, as compared to March 31, 2021, was also primarily attributed to the Company’s reduction of pandemic related qualitative factors within the allowance model.

The Company reported net recoveries in the first quarter of 2022 of $166 thousand, compared to no net charge offs or recoveries for the first quarter of 2021 and net recoveries of $142 thousand for the fourth quarter of 2021.

The provision for credit losses was $200 thousand for the second quarter of 2022, $650 thousand for the second quarter of 2021 and $600 thousand for the first quarter of 2022.

The decrease in the provision for credit losses during the second quarter of 2022 as compared to the prior quarters was primarily attributable to significant net recoveries.

The ratio of the allowance for credit losses to period-end loans was 0.68% at June 30, 2022, 0.67% at March 31, 2022 and 1.02% at June 30, 2021.

Excluding PPP loans and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.89% at June 30, 2022, slightly lower than the 0.92% at March 31, 2022 and lower than the 1.12% at June 30, 2021.

The decline in the percentage of the allowance from the second quarter of 2021 was primarily the result of improved credit quality, including lower historical loss experience as well as lower pandemic related qualitative reserves.

The Company reported net recoveries in the second quarter of 2022 of $573 thousand, compared to net recoveries of $125 thousand for the second quarter of 2021 and net recoveries of $166 thousand for the first quarter of 2022.

Management continually evaluates the adequacy of the allowance for credit losses as changes in the environment and within the portfolio become known.

The Company reported income tax expense of $1.9 million for the first quarter of 2022, $1.4 million for the first quarter of 2021 and $1.3 million for the fourth quarter of 2021.

Income tax expense increased when compared to both the first quarter of 2021 and fourth quarter of 2021 due to higher pre-tax earnings.

The effective tax rate for the first quarter of 2022 was 25.6%, 31.8% for the fourth quarter of 2021, and 26.4% for the first quarter of 2021.

The higher tax rate in the fourth quarter of 2021 was attributed to non-deductible merger-related expenses in the quarter.

The provision for credit losses for the six months ended June 30, 2022 and 2021 was $800 thousand and $1.1 million, respectively, while net recoveries were $739 thousand and $125 thousand, respectively.

The decrease in provision for credit losses was the result of significant recoveries in the first six months of 2022 and overall improved credit quality.

The ratio of allowance to total loans increased from 0.66% at December 31, 2021, to 0.68% at June 30, 2022.

Excluding PPP and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.89% at June 30, 2022, lower than the 0.93% at December 31, 2021.

The primary drivers for the decrease in the percentage of allowance for credit losses to total loans were significant originations within the construction and consumer loan portfolios and the acquisition of Severn.

The ratio of annualized net recoveries to average loans was 0.07% for the first half of 2022, compared to annualized net recoveries to average loans of 0.03% for the first half of 2021.

Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as changes within the Company’s portfolio are known.

The Company reported income tax expense of $2.7 million for the second quarter of 2022, $1.4 million for the second quarter of 2021 and $1.9 million for the first quarter of 2022.

Income tax expense increased when compared to both the second quarter of 2021 and first quarter of 2022 due to higher pre-tax earnings.

The effective tax rate for the second quarter of 2022 was 26.2%, 25.6% for the first quarter of 2022, and 26.4% for the second quarter of 2021.

Income tax expense was $4.6 million for the six months ended June 30, 2022, and $2.9 million for the six months ended June 30, 2021.

The effective tax rate was 25.9% for the six months ended June 30,2022, and 26.4% for the six months ended June 30, 2021.

ANALYSIS OF FINANCIAL CONDITION

1 unchanged sentence

We originate residential mortgage loans for sale on the secondary market, which we have elected to carry at fair value.

At March 31, 2022 and December 31, 2021, the fair value of loans held for sale amounted to $12.9 million and $37.7 million, respectively.

At June 30, 2022 and December 31, 2021, the fair value of loans held for sale amounted to $7.3 million and $37.7 million, respectively.

When we sell mortgage loans we make certain representations to the purchaser related to loan ownership, loan compliance and legality, and accurate documentation, among other things.

1 unchanged sentence

Loans Held for Investment

The following tables represent the composition of the Company’s loan portfolio at March 31, 2022 and December 31, 2021.

March 31, 2022

The following tables represent the composition of the Company’s loan portfolio at June 30, 2022 and December 31, 2021.

June 30, 2022

Loans acquired from

15 unchanged sentences

Total loans, net

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $506.5 million in total loans remained outstanding as of March 31, 2022.

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $451.8 million in total loans remained outstanding as of June 30, 2022.

Excluding these loans and legacy PPP loans, total legacy loans increased $263.5 million, or 17.0%, when compared to December 31, 2021.

At March 31, 2022 and December 31, 2021, PPP loans accounted for $14.9 million and $18.4 million of total loans, respectively.

At June 30, 2022 and December 31, 2021, PPP loans accounted for $1.4 million and $18.4 million of total legacy loans, respectively.

Most of our loans, excluding PPP loans, are secured by real estate and are classified as construction, residential or commercial real estate loans.

The increase in legacy loans, excluding PPP loans, was comprised of increases in consumer loans of $38.3 million, or 30.7%, construction loans of $34.1 million, or 23.5%, commercial real estate loans of $37.8 million, or 5.6%, residential real estate loans of $14.5 million, or 3.1%, partially offset by a decrease in commercial loans of $12.9 million, or 10.0%, at March 31, 2022 compared to December 31, 2021.

At March 31, 2022, the legacy loan portfolio, excluding PPP loans, was comprised of 43.2% commercial real estate, 29.2% residential real estate, 10.8% construction, 9.8% consumer and 7.0% commercial.

The increase in legacy loans, excluding PPP loans, was comprised of increases in consumer loans of $69.4 million, or 55.7%, construction loans of $63.4 million, or 43.7%, commercial real estate loans of $72.6 million, or 10.7%, residential real estate loans of $71.8 million, or 15.3%, partially offset by a decrease in commercial loans of $13.6 million, or 10.6%, at June 30, 2022 compared to December 31, 2021.

At June 30, 2022, the legacy loan portfolio, excluding PPP loans, was comprised of 41.5% commercial real estate, 29.9% residential real estate, 11.5% construction, 10.7% consumer and 6.3% commercial.

That compares to 43.9%, 30.4%, 9.4%, 8.0% and 8.3, respectively, at December 31, 2021.

Outstanding PPP loans totaled $14.9 million at March 31, 2022 and $27.6 million at December 31, 2021, a decrease of $12.7 million or 45.9%.

The decrease was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021.

Outstanding PPP loans totaled $1.7 million at June 30, 2022 and $27.6 million at December 31, 2021, a decrease of $25.8 million or 93.7%.

was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021.

We do not engage in foreign or subprime lending activities.

1 unchanged sentence

Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans.

Construction loans were $258.2 million, or 11.8% of total loans, at March 31, 2022 and $239.4 million, or 11.3% of total loans, at December 31, 2021.

Commercial real estate loans were $928.1 million, or 42.6% of total loans, at March 31, 2022, compared to $896.2 million, or 42.3% of total loans, at December 31, 2021.

Construction loans were $263.1 million, or 11.6% of total loans, at June 30, 2022 and $239.4 million, or 11.3% of total loans, at December 31, 2021.

Commercial real estate loans were $953.1 million, or 42.1% of total loans, at June 30, 2022, compared to $896.2 million, or 42.3% of total loans, at December 31, 2021.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending.

3 unchanged sentences

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

At March 31, 2022, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 291.4% of total risk-based capital.

At June 30, 2022, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 292.2% of total risk-based capital.

At such time, construction, land and land development loans represented 80.4% of total risk-based capital.

9 unchanged sentences

Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology management employs to maintain the allowance.

The allowance for credit losses was $14.7 million at March 31, 2022, $13.9 million at December 31, 2021 and $14.3 million at March 31, 2021.

There were net recoveries of $166 thousand for the first quarter of 2022, compared to net recoveries of $142 thousand for the fourth quarter of 2021 and no net charge offs or recoveries for the first quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.03% for the first quarter of 2022, compared to annualized net recoveries of 0.03% for the fourth quarter of 2021 and 0.00% for the first quarter of 2021.

The allowance for credit losses was $15.5 million at June 30, 2022, $13.9 million at December 31, 2021 and $15.1 million at June 30, 2021.

There were net recoveries of $573 thousand for the second quarter of 2022, compared to net recoveries of $166 thousand for the first quarter of 2022 and net recoveries of $125 thousand for the second quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.10% for the second quarter of 2022, compared to annualized net recoveries of 0.03% for the first quarter of 2022 and annualized net recoveries of 0.03% for the second quarter of 2021.

Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to continue to improve its overall credit quality.

The allowance for credit losses as a percentage of period-end loans was 0.67% at March 31, 2022 and 0.66% at December 31, 2021.

Excluding PPP loans and acquired loans from Severn and Northwest, the ratio of the allowance for credit losses to period-end loans was 0.92% at March 31, 2022, slightly lower than the 0.93% at December 31, 2021.

The decrease in the percentage of the allowance to total loans, excluding PPP loans and acquired loans, at March 31, 2022 compared to December 31, 2021, was primarily due to the reduction of pandemic

related qualitative factors.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at March 31, 2022.

The following table presents a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2022 and 2021.

The allowance for credit losses as a percentage of period-end loans was 0.68% at June 30, 2022 and 0.66% at December 31, 2021.

Excluding PPP loans and acquired loans from Severn and Northwest, the ratio of the allowance for credit losses to period-end loans was 0.89% at June 30, 2022, lower than the 0.93% at December 31, 2021.

The decrease in the percentage of the allowance to total loans, excluding PPP

loans and acquired loans, at June 30, 2022 compared to December 31, 2021, was primarily the result of improved credit quality, including lower historical loss experience as well as lower pandemic related qualitative factors.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at June 30, 2022.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and six months ended June 30, 2022 and 2021.

For the Three Months Ended

March 31, 2022

March 31, 2021

June 30, 2022

June 30, 2021

Percentage of net

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Commercial real estate

Average loans outstanding during the period

Allowance for credit losses at period end as a percentage of total period end loans (1)

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Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At March 31, 2022 and March 31, 2021, these ratios included all loans held for investment, including PPP loans of $14.9 million and $129.1 million, respectively.

(2) At March 31, 2022 and March 31, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At March 31, 2022 and March 31, 2021, these ratios included all loans held for investment, including PPP loans of $18.9 million and $131.9 million, respectively.

(1) At June 30, 2022 and June 30, 2021, these ratios included all loans held for investment, including PPP loans of $1.7 million and $86.8 million, respectively.

(2) At June 30, 2022 and June 30, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At June 30, 2022 and June 30, 2021, these ratios included all loans held for investment, including PPP loans of $7.6 million and $116.9 million, respectively.

June 30, 2022

June 30, 2021

Percentage of net

charge-offs (recoveries)

(annualized) to

average loans

Net (charge-offs)

(Dollars in thousands)

Average balances

during the year

Average balances

during the year

Residential real estate

Commercial real estate

Allowance for credit losses at period end as a percentage of total period end loans (1)

Allowance for credit losses at period end as a percentage of total period end loans (2)

Allowance for credit losses at period end as a percentage of average loans (3)

Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At June 30, 2022 and June 30, 2021, these ratios included all loans held for investment, including PPP loans of $1.7 million and $86.8 million, respectively.

(2) At June 30, 2022 and June 30, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At June 30, 2022 and June 30, 2021, these ratios included all loans held for investment, including PPP loans of $13.0 million and $124.3 million, respectively.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets were $3.9 million and $3.0 million at March 31, 2022 and December 31, 2021, respectively.

The balance of nonperforming assets increased primarily due to an increase in nonaccrual loans of $844 thousand, or 42.1%.

As shown in the following table, nonperforming assets were $3.7 million and $3.0 million at June 30, 2022 and December 31, 2021, respectively.

The balance of nonperforming assets increased primarily due to an increase in nonaccrual loans of $689 thousand, or 34.4% primarily due to the acquisition of Severn.

Accruing troubled debt restructurings (“TDRs”) decreased $773 thousand, or 13.6%, over the same time period.

Other real estate owned properties increased to $561 thousand from $532 thousand at December 31, 2021.

The ratio of nonaccrual loans and accruing TDRs to total loans stayed the same at 0.36% at March 31, 2022 and December 31, 2021.

Other real estate owned properties decreased to $197 thousand at June 30, 2022 from $532 thousand at December 31, 2021.

The ratio of nonaccrual loans and accruing TDRs to total loans ratio at June 30, 2022 was 0.34% compared to 0.36% at December 31, 2021.

The Company continues to focus on the resolution of its nonperforming and problem assets.

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The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.

The following table summarizes our nonperforming assets and accruing TDRs at March 31, 2022 and December 31, 2021.

The following table summarizes our nonperforming assets and accruing TDRs at June 30, 2022 and December 31, 2021.

(Dollars in thousands)

March 31, 2022

June 30, 2022

December 31, 2021

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The investment portfolio is comprised of debt and equity securities.

Debt securities are classified as either available for sale or held to maturity.

Securities are classified as either available for sale or held to maturity.

Investment securities available for sale are stated at estimated fair value based on quoted prices.

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We have the intent and ability to hold such securities until maturity.

At March 31, 2022, 21.5% of the portfolio of debt securities were classified as available for sale and 78.5% was classified as held to maturity, compared to 22.6% and 77.4% respectively, at December 31, 2021.

At June 30, 2022, 18.6% of the portfolio of debt securities was classified as available for sale and 81.4% was classified as held to maturity, compared to 22.6% and 77.4% respectively, at December 31, 2021.

See Note 4 – “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities including restricted stock totaled $525.0 million at March 31, 2022, a $2.1 million, or less than 1%, decrease since December 31, 2021.

The decrease was primarily due to proceeds from maturities and principal repayments of available for sale securities of $7.0 million and held to maturity securities of $11.3 million, partially offset by purchases of held to maturity securities of $14.1 million, purchases of restricted securities of $5.7 million and purchases of equity securities of $3 thousand.

At March 31, 2022, 78.2% of the securities available for sale were mortgage-backed, 19.9% were U.S.

Investment securities including restricted stock totaled $564.8 million at June 30, 2022, a $37.7 million, or 7.15%, increase since December 31, 2021.

The increase was primarily due to purchases of held to maturity securities of $78.5 million, purchases of restricted securities of $5.7 million and purchases of equity securities of $7 thousand partially offset by proceeds from maturities and principal repayments of available for sale securities of $12.8 million and held to maturity securities of $23.6 million.

At June 30, 2022, 77.4% of the securities available for sale were mortgage-backed, 20.6% were U.S.

Government agencies and 2.0% were corporate bonds, compared to 79.2%, 19.1% and 1.7%, respectively, at year-end 2021.

At March 31, 2022, 74.9% of the securities held to maturity were mortgage-backed, 21.3% were U.S.

At June 30, 2022, 73.8% of the securities held to maturity were mortgage-backed, 23.3% were U.S.

Government agencies, 2.8% were subordinated debt instruments and less than 1% were community reinvestment bonds, compared to 74.8%, 21.4%, 3.6% and less than 1%, respectively, at year-end 2021.

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Government agencies or government-sponsored agencies.

The decline in fair values on available for sale securities in the first quarter of 2022 was the result of the recent volatility in interest rates and are not indicative of any credit concerns due to the Company holding high quality securities.

Total deposits at March 31, 2022 amounted to $3.07 billion, an increase of $42.3 million, or 1.4%, when compared to the level at December 31, 2021.

The increase in total deposits consisted of an increase in checking accounts of $171.3 million, partially offset by a decrease in savings and money market accounts of $77.9 million and noninterest-bearing deposits of $51.1 million.

The decline in fair values on available for sale securities in the first quarter of 2022 was the result of the recent increases in interest rates and are not indicative of any credit concerns due to the Company holding high quality securities.

Total deposits at June 30, 2022 amounted to $3.01 billion, a decrease of $11.9 million, or less than 1%, when compared to the level at December 31, 2021.

The decrease in total deposits consisted of a decrease in money market and savings accounts of $79.7 million, $38.4 million in noninterest bearing deposits and $11.9 million in time deposits partially offset by an increase in interest bearing checking accounts of $118.1 million.

Short-Term Borrowings

Short-term borrowings consisted of securities sold under agreements to repurchase, which decreased by $4.1 million, or 100%, at March 31, 2022 when compared to December 31, 2021.

The Company had no short-term borrowings as of June 30, 2022, compared to short-term borrowings consisting of securities sold under agreements to repurchase of $4.1 million at December 31, 2021.

Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors.

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Short-term advances are defined as those with original maturities of one year or less.

At March 31, 2022 and December 31, 2021, the Company had no outstanding short-term advances with FHLB.

At June 30, 2022 and December 31, 2021, the Company had no outstanding short-term advances with the FHLB.

Long-Term Debt

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The acquisition of Severn added $10.1 million in long-term FHLB borrowings, which carried an interest rate of 2.19%, and a maturity date of October 2022.

The balance of this debt was $10.1 million at both March 31, 2022 and December 31, 2021.

The balance of this debt was $10.1 million at both June 30, 2022 and December 31, 2021.

The Company uses long-term borrowings to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient.

On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

On October 31, 2021, the Company acquired from the Severn merger, Junior Subordinated Debt Securities due in 2035 (“2035 Debentures”) which had an outstanding principal balance of $20.6 million.

The debt balance of $18.2 million at March 31, 2022 is presented net of a fair value adjustment of $2.4 million at March 31, 2022 and December 31, 2021.

As a result of the Severn merger, the Company acquired Junior Subordinated Debt Securities due in 2035 (“2035 Debentures”) which had an outstanding principal balance of $20.6 million.

The debt balance of $18.3 million at June 30, 2022 and $18.2 million at December 31, 2021 is presented net of a fair value adjustment of $2.3 million and $2.4 million, respectively.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $12.6 million for the first three months of 2022 compared to an increase of $40.2 million for the first three months of 2021.

The decrease in cash and cash equivalents in 2022 was mainly due to funding net loan growth of $61.2 million and a purchase of bank owned life insurance of $10 million.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $180.6 million for the first six months of 2022 compared to an increase of $50.3 million for the first six months of 2021.

The decrease in cash and cash equivalents in 2022 was mainly due to funding net loan growth of $143.9 million and purchases of securities held to maturity of $78.5 million.

To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets.

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The Bank is also a member of the FHLB, which provides another source of liquidity.

Through the FHLB, the Bank had collateral pledged of approximately $283.1 million and $363.9 million at March 31, 2022 and December 31, 2021, respectively.

Through the FHLB, the Bank had collateral pledged of approximately $290.0 million and $363.7 million at June 30, 2022 and December 31, 2021, respectively.

The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

Total stockholders’ equity increased $1.2 million to $351.9 million, or less than 1%, at March 31, 2022 when compared to December 31, 2021 primarily due to the current year’s retained earnings, partially offset by dividends paid during the first three months of 2022 and the change in fair value of available-for-sale securities recorded in accumulated other comprehensive income (loss).

Total stockholders’ equity increased $2.1 million, or less than 1%, to $352.8 million at June 30, 2022 when compared to December 31, 2021 primarily due to the current year’s retained earnings, partially offset by an increase in unrealized losses

of $6.7 million (net of tax) on available for sale securities and dividends paid which are recorded in accumulated other comprehensive income (loss).

The Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies.

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The Bank and Company are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.

The following tables present the applicable capital ratios as of March 31, 2022 and December 31, 2021.

The following tables present the applicable capital ratios as of June 30, 2022 and December 31, 2021.

Common Equity

March 31, 2022

June 30, 2022

capital ratio

9 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis